DOCAs for Builders: Business Rescue for Construction Companies?

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A Deed of Company Arrangement (DOCA) is an important business rescue mechanism in Australia enabled via the Voluntary Administration procedure. Here, we look at how DOCAs can support builders, both where they are the debtor and where they are the creditor in a particular insolvency event. Company directors only have a few weeks to propose a DOCA to creditors before it goes out to the creditors in a report. The construction industry has some unique issues that we consider below.

Why Builders Might Consider a DOCA

When the directors of a company consider that their company is insolvent, or may become insolvent, they have a decision to make: Attempt to turn the business around, or close it down (for example via winding up proceedings). 

Where directors think that there is a prospect of turning the business around, there are a few potentially suitable rescue mechanisms available: 

• An Informal Workout. Directors can engage with their creditors directly in an attempt to negotiate an agreement outside a formal insolvency appointment. While this can be carried out lawfully through the ‘Safe Harbour’ in section 588GA of the Corporations Act 2001 (Cth), it will only bind creditors who agree. That means this usually won’t be an option where there are many different creditors (as those left ‘out of the money’ will have every incentive to hold out for full repayment). 
• Small Business Restructuring (SBR). Regulated by Part 5.3B of the Corporations Act 2001 (Cth), this procedure is limited to smaller companies that are otherwise up-to-date with their tax lodgments and entitlement payments. This is a fast mechanism (20 business days in the initial phase, with the Directors remaining in control of the company (‘debtor in possession’)) whilst they propose a Restructuring Plan to creditors. With the assistance of a Restructuring Practitioner, a plan can be put to unsecured creditors. If agreed to by more than 50 percent of creditors in value, the company’s debt is restructured and the Restructuring Plan is binding on all unsecured creditors. 
• Voluntary Administration. In Voluntary Administration, Directors resolve to appoint an independent Insolvency Practitioner, the Voluntary Administrator, who takes control of the business. Through the Voluntary Administration procedure, the Directors can propose a DOCA (usually involving significant debt restructuring), which is voted on by creditors. If passed by more than 50 percent of creditors in value and number, the company leaves Voluntary Administration and implements the DOCA. 

In principle, a builder could restructure their company through a Creditors’ Voluntary Liquidation as well. For example, this could be achieved through the Liquidator selling assets or the business as a whole to the Directors or related parties (at arm’s length/market value to avoid illegal phoenixing). But this is not recommended by insolvency professionals due to the risk of litigation from out-of-the-money creditors. 

What Benefits Does a DOCA Have Over Other Restructuring Options?

Once the company goes into Voluntary Administration, the Voluntary Administrator takes control of the company and has a broad remit to decide what the next steps are. One option, where proposed by a Director or a creditor, is to recommend a DOCA to the creditors at the second creditor’s meeting. The other options available to creditors are to vote for liquidation or to return the company to Directors. Note, as a builder, you should not be surprised to see a subcontractor revolt during this process if they choose to vote against a DOCA because they are dissatisfied with the returns and suspect insolvency pre-planning occurred whilst they were servicing jobs. 

The DOCA itself is broadly defined, as a binding agreement, with creditors, on the affairs of the insolvent company (ASIC). Once a DOCA is agreed to at the second creditors’ meeting it is overseen by the ‘Deed Administrator’ (almost always the same person as the Voluntary Administrator) whose responsibilities and entitlements are set out in the DOCA. One common use for the DOCA is for a debt compromise: Creditors agree to take a haircut and receive payments on their debt according to a future pay schedule, often paid out of future trading profits. 

But the DOCA is flexible and supports more options than just a simple debt compromise. It might also support: 

• Continuation of trading for a defined period (e.g., just Work-in-Progress Builds)
• Limitations on Directors, or an agreement that a director be replaced 
• The sale of a business as a going concern. An agreement for sale and purchase of the business is sometimes conditional on a DOCA approving of the sale. As the creditors are bound by the DOCA, this reduces the likelihood of creditors mounting a legal challenge to the sale. 
• Debt-for-Equity swaps. This involves significant creditors giving up their claim to a provable debt in return for equity in the company. 
• Litigation initiated by the Voluntary Administrator to further enhance the asset pool. 

By contrast, the other key restructuring option, an SBR, is more restricted and must be carried out according to the prescribed form. While that form does permit asset sales, it is focused on a debt restructure. 

There are limitations on SBR that don’t apply to DOCAs: Tax lodgments and employee entitlement payments must be up-to-date, and the overall debts of the company must not exceed $1 million. There is also a limitation on companies engaging in this process if any of its Directors (or those who have been a director in the past year) have been through SBR in the last seven years.

DOCA Pitfalls for Builders

There are some special matters that builders need to pay attention to if considering a DOCA. 

• ATO Perspective. Most insolvent construction businesses have significant tax debts, making the ATO their largest unsecured creditor. The ATO places a lot of emphasis on compliance with tax lodgment obligations when deciding whether to approve or reject a DOCA proposal. This means that taking positive steps to tighten tax compliance within a business could be very important to securing the support of the ATO for a DOCA proposal.
• Contractors’ retentions and subcontractor chains. Sometimes amounts are held by the debtor builder from subcontractors as a retention (e.g., 5 percent withheld until completion). Unless this is held under a deemed statutory trust, or the narrow circumstances of an implied or constructive trust apply, the subcontractors will be ordinary unsecured creditors for this amount. That means subcontractors will have to weigh up potential returns on a DOCA or Liquidation before voting for a DOCA and mismanagement of these funds could cause a subcontractor revolt against the DOCA proposal.
• Latent defects and warranty tails. Warranty tails, the long period under which the builder may be liable for any defects or mistakes, should be accounted for before a DOCA is proposed. The protection against future litigation is a well-accepted motivation for DOCA proposal and contingent claims are usually restructured through an accepted DOCA.
• Project Bank Accounts and Statutory Trust Funds. Where state law requires that subcontractor funds are held in a statutory trust fund, those amounts do not vest in the Voluntary Administrator and do not constitute part of the ‘DOCA pool’ for potential distribution. These accounts should be reconciled before a Voluntary Administration is commenced to ensure that these funds aren’t mixed with the company’s working capital funds.
• Contract termination risk during the DOCA. During the Voluntary Administration, head contractors and suppliers are prohibited from exercising any ‘ipso facto’ clauses in their contracts which allow them to terminate on the occurrence of an insolvency event. The legal objective of these laws is to keep construction projects on foot during a voluntary administration to preserve business goodwill – at least for a short time. Once the Voluntary Administration is over and DOCA execution begins, head contractors can terminate construction contracts due to the triggering of insolvency events. This means it is essential to negotiate these matters with such contractors/suppliers before the Voluntary Administration ends. Alternatively, builder debtors should account for the loss of many of these contracts. Further, if the company is in breach of other essential terms of construction contracts (such as delay) they will not be able to rely on ipso facto protections.
• The interaction of security of payments law (SOPA) and DOCAs. SOPA claims are not enforceable during a liquidation but they are enforceable through a DOCA. See Façade Treatment Engineering v Brookfield. This means that DOCAs could be burdened with more debt through SOPA claims than a liquidation. 
• Licensing issues. There may be disqualification risk through a liquidation compared to a DOCA. Careful consideration of the risk to owner/operatings from building legislation should be undertaken if relevant. 
• Director liability for personal guarantees. DOCAs do not save company directors from personal guarantee liabilities and liabilites from director penalty notices. This undermines the value of DOCAs because it captures the principal debt (such as the tax debt) but not the personal liability for company directors. 
• Government and tier-1 prequalification. The consequence that hurts most is often not the debt compromise but the loss of access to work. Government agencies and tier-1 head contractors maintain prequalified tender panels with solvency criteria, and a VA or DOCA will usually trigger suspension or removal — sometimes automatically — with slow and uncertain reinstatement, even after a successful DOCA. A builder whose pipeline depends on panel work should weigh this carefully: a DOCA may rescue the balance sheet but still leave the business unable to win the projects it needs to trade out. Factor this into any realistic assessment of post-DOCA viability.

DOCA for Builders: The Creditor Perspective

So far the focus has been on what a DOCA means for debtor builders and the directors of those companies. But what about the implications for creditors? Creditors should consider:

• How does the DOCA treat them? In corporate insolvency, creditor entitlements under a DOCA can differ by class. Creditors need to check that any prospective DOCA respects any existing security interests, whether they have preferential status, and whether a statutory trust applies to any monies held by the builder. They might also seek legal advice on how to challenge a discriminatory DOCA in the courts. 
• DOCA vs SBR vs Liquidation. Creditors have significant control over DOCA and SBR proceedings (through their vote). In the case of liquidation, this control is curtailed, but there is always the ability to challenge Liquidator decisions in court. Creditors should consider their potential returns according to each procedure. Creditors should also keep in mind that even if a liquidation scenario could provide a larger return this could be swallowed up in professional fees and incorrect assumptions. 

As some practical steps for subcontractor creditors, we would suggest the following: 

1. Attend both meetings of creditors where possible. A committee of inspection can also be appointed where the creditors want a more active role in proceedings. You might propose the company provide cashflow projections for the next 12 months as part of this process, for example. 
2. Carry out due diligence on any DOCA proposal. Scrutinise the Administrator’s report and rationale given for supporting the DOCA. Pay special attention to any proposed returns for creditors and ask that it be compared with the liquidation outcome. 
3. Use common sense to calculate whether there is going to be a return. The vast majority of liquidations don’t produce a return so any returns from a DOCA, including small returns would be likely to be greater than a liquidation. 

DOCAs for Builders — Our Take 

DOCAs via a Voluntary Administration is likely to be the most viable restructuring process for directors whose business is ineligible for SBR. However, before going down the VA/DOCA route, all directors should be realistic about whether creditors will agree to the DOCA and what the eventual outcome will be.  The directors should also undertake housekeeping such as reconciling retentions amounts, improving tax lodgment compliance and calculating returns to creditors from a DOCA proposal.

On their own side, subcontractor creditors should play an active role in the Voluntary Administration process, ensure that their claims are correctly classified, and compare their likely returns from a DOCA vs a winding up before voting to approve of a DOCA.  However, whilst taking a pro-active role they should be realistic by assuming any returns they receive through a successful turnaround will be much lower than 100% of their debt.